It’s axiomatic in dividend investing that the best dividend stocks score highly on dividend yield, consistency, and growth. When you are emphasizing dividends (rather than exclusively on price), you obviously want to own companies which have a good initial yield (more than a bank deposit),
pay their dividends without fail, and increase their dividends regularly.
Much like every form of stock investing, all you need to take in selecting individual stocks is history and conjecture. Conjecture consists of drawing reasonable inferences from the annals and current conditions.
Regarding history, you want to find stocks which have a demonstrated record of paying dividends consistently (never missing a payment) and raising them often. In my own e-book, “The Top 40 Dividend Stocks for 2008,” I present a scoring system for rating stocks along these two scales (plus several others) that I call the Easy-Rate(TM) system.
A company’s history of dividend payments tells you a few things that you could reasonably project into the future. For example, if your company has paid a dividend every quarter for ten straight years, and raised the dividend in seven of these years, that implies that the company is run in such a way that dividend-paying may be the norm. Management expects to continue to pay the dividend every quarter, and they manage their money accordingly. They know they’ve a constituency of shareholders who expect that dividend and periodic increases, and they “play to” that constituency simulador. Skipping a payment or cutting the dividend could possibly cause many shareholders to abandon the stock, bringing a disastrous fall in the stock’s price.
But any projection into the near future is conjecture, isn’t it? There is risk in virtually any prediction, from weather forecasting, to picking your fantasy football team, to selecting the best stocks. Even when the “chances are with you,” or “all signs point because direction,” there’s risk that any prediction will soon be wrong.
And so it’s with dividend stocks. Even when we take the utmost precautions to select only stocks with an excellent yield, great dividend history, and the strongest signs of continuing that history, we can be wrong.
The financial sector in the past 12 months provides some vivid examples of such risk. Many retail banks, commercial banks, investment banks, and mortgage lenders have been pummeled by the sub-prime mortgage crisis, which morphed into a full-blown credit crisis. The iconic Bear Stearns failed (it was bailed out by the government). The iconic Citigroup slashed its dividend along with more than 10,000 jobs. Countrywide Financial, the country’s largest mortgage issuer, nearly went of business, “saved” only by being purchased at a fire-sale price by Bank of America.
In my own e-book, I selected Bank of America (BAC) as one of the Top 40 dividend stocks. It’d a 6.6% yield, good valuation, and had raised its dividend for a lot more than 25 straight years — a select club with only 59 members. But BAC has been hit hard by the credit crisis, and it’s hard to tell whether the acquisition of Countrywide, even for a song, is good or bad in the short term. (It might be great in the long term.)
BAC, like a lot of banks right now, needs money. One way to get money, obviously, is always to cut its dividend. So BAC’s dividend is “at risk.” Up to now, BAC has resisted that temptation. It paid its first-quarter dividend, even although the payout exceeded its profits. It paid its second-quarter dividend on June 4. Its next dividend (not yet declared) is scheduled for September 28 — and that is normally the quarterly payment by which BAC increases its dividend each year. In its second quarter report several days ago, CEO Ken Lewis stated that management has recommended to the board that the third-quarter payout proceed as scheduled. That is in line with earlier statements from Lewis, who’d said he “views the dividend as safe” (as reported by MarketWatch) shortly following the second-quarter payout in June.
As a result of significant price drop, BAC in June was yielding a sky-high 11.4%, and several analysts and pundits stated flatly that BAC will have to cut its dividend, as it needed the money. Ends up they were wrong, at the least with this quarter.
I kept BAC on my Top 40 list, and it’s still there. I own shares. It turns out that after industry heard the recent news about BAC’s second-quarter results, it had been so relieved that the stock jumped a lot more than 70% in just a few days.
Other than the peril of the dividend being cut, BAC satisfies all my requirements for a high dividend stock. Even at its recovering price (back planning to where it had been in mid-May), you could argue that this is a once-in-a-lifetime opportunity to acquire a world-class company — that will now become the nation’s largest mortgage lender — at a yield that still exceeds 7%. Chances like that do not show up often. Notice that if the dividend isn’t cut, that 7% yield to a new purchaser will never drop in relation to the first investment. Actually, it should go up if and when BAC increases its dividend.
Should BAC still be on my Top 40 list? Maybe. Do you believe Lewis when he says the dividend is “safe”? What can you expect him to say? You think BAC will raise its dividend in 2010? I don’t, but that alone doesn’t disqualify the company. Do you believe that at some point in the future, the financial sector will recover, and stocks like BAC will go back to former prices? I really do, although it will probably take a few years. Remember the savings and loan crisis of the 1980’s and 1990’s? Banks recovered from that, albeit with a lot of government help and several bank failures. A similar scenario is playing out today: Lots of government help, along with some failures.
Being an investor, you may make up your own personal mind about Bank of America. For my money, it looks like an excellent long-term investment. The opportunity of it failing is near zero. Its dividend is remarkably high for such a strong business. And I believe it’s planning to weather this storm and continue re-appreciating in price.
I’m focused on the dividend, so I’m not as focused on just how long that takes as I could be with a “growth” stock. Meanwhile, I’ll happily collect my checks each quarter.